The Basic Law of Price Determination

I must begin by making the following crystal clear: prices are determined in the market as a result of a social process fueled by entrepreneurship. This is obvious, but we need to repeat it, because the vast majority of my colleagues—economics professors and department heads—present the determination of prices as if it resulted from the intersection of mysterious curves or functions, etc. I will present a radically different analysis or explanation of how prices are set in the market. I am going to describe a social process led by flesh-and-blood men and women who are endowed with an innate entrepreneurial capacity. We cannot possibly understand how prices are determined if we do not first have a sound grasp of the nature of entrepreneurship. That is why we have devoted so much time and effort to studying it analytically. Well, we saw that in a system based on the division of knowledge or labor, an incredibly powerful force leads us to make exchanges, because, in keeping with the law of marginal utility, each person values very little what he already has and what he has specialized in producing, and he values very highly what he lacks and others have. So, we are more or less destined to make exchanges with each other. In addition, we saw that society, the market, is a process, an extremely complex network of human interactions which basically consist of exchange relationships. Well, we are going to study four different types of exchange processes that give rise to monetary prices, and we will go from the simplest case to the broadest and most general case. The simplest case is that of an isolated exchange. Next, we’ll consider one-sided competition among buyers—for example, an auction (to give you a clear, visual idea). Then, we’ll look at one-sided competition among sellers. And last, we’ll study two-sided or bilateral competition.